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SMSFs and the pension cap: a case study

Four questions every SMSF member with large balances should be asking in the run up to 30 June 2017. There’s enough here to warn not to leave understanding the rules until the last minute.


A recent article set the scene for how SMSFs will need to re-assess their pensions under the $1.6 million pension cap. The comments and questions received highlight the complexity of this reform for SMSF trustees. To further decode the changes, we found there are four key questions regarding these reforms:

To demonstrate the key points, we have developed the following case study:

Case study – Fred and Wilma’s SMSF

Fred, aged 68, and Wilma, aged 69, are both fully retired and, as at 7 December 2016, have:

Outside super, they also have a share portfolio valued at $130,000, a cash bank account valued at $20,000 and an investment property valued at $550,000, all in joint names.

These non-super investments produce $32,500 per year from dividends, interest and rent. Minimum payments from the SMSF provide $95,000 on top of the $50,000 from the Slate lifetime pension.

Fred and Wilma are living within their means and will spend only $100,000 this year. The excess is invested in their share portfolio.

1. How will member accounts be tracked from 1 July 2017?

The first step is to determine whether either member is affected by the $1.6 million pension cap at 1 July 2017.

Wilma has a total retirement phase balance today of $700,000. This is not likely to exceed $1.6 million by 1 July 2017 so no change to her account is required.

Fred has $1.2 million in the SMSF in pension phase and the $50,000 a year lifetime pension. To value the defined pension under the new reforms we take the annual payment and multiply it by 16 (this is independent of the age of the retiree). The defined pension is valued at 50,000 x 16 = $800,000. So Fred’s total retirement phase balance of $2 million is $400,000 in excess of the cap.

Fred must either commute the excess out of retirement phase back to accumulation, or withdraw it altogether from superannuation. By 1 July 2017, he can only have a maximum of $1.6 million in retirement phase. Since the lifetime pension is non-commutable, he will have to commute the excess from his SMSF.

Wilma and Fred currently have $16,250 each in taxable income each year from their non-super income. Their pension payments are tax free. They currently pay no income tax.

If Fred were to withdraw $400,000 from super and invest it outside super (in joint names) then earnings from those investments would increase the household’s taxable income.

Say these produced 5% earnings then this would increase Wilma and Fred’s taxable income to $26,250 each. Due to SAPTO and LITO offsets they would also pay no tax outside of super this year. They can receive up to about $58,000 in combined household taxable income before they would need to pay tax.

If Fred transfers $400,000 back to accumulation inside super then a proportion of earnings on all fund assets would be assessable income and taxed at 15%. The tax-exempt percentage would be around 80% for 2017-18 and so if the SMSF also received 5% income on investments then this would produce taxable income around $19,000 and subject to imputation credits the SMSF would pay some tax.

Taking money out of super is irrevocable for Fred and Wilma as neither is able to re-contribute to super. After a few years, as their non-super investments increase due to not spending all of their income, Fred and Wilma expect their taxable earnings to increase and they might start paying more tax than if the assets remained in super.

Fred and Wilma decide to manage their future tax position and leave the excess in superannuation. This will create a new accumulation account for Fred. They decide that this new accumulation account will be created on 30 June 2017 to ensure that Fred’s pension balance at 1 July 2017 is no more than $800,000.

2. Can the fund employ a segregated asset strategy?

There is no requirement to segregate assets to this new accumulation account. Indeed, the SMSF will not be allowed to employ a segregated strategy from 1 July 2017 due to Fred having a total retirement phase balance of $1.6 million.

All assets will be unsegregated and from 2017-18 onwards the fund will need to determine the tax-exempt percentage to claim Exempt Current Pension Income (ECPI).

3. Is the fund eligible to preserve capital gains on some or all fund assets?

The fund will have some balances moving out of the pension phase to the accumulation phase as a direct result of the changes. The fund is therefore eligible to apply the CGT relief to reset the cost base of assets to ‘lock in’ gains earned under the current rules.

Since all fund assets will be affected by the requirement to comply with the $1.6 million cap due to now being unsegregated from 30 June 2017, the fund is eligible to apply the CGT relief on all assets. However, the SMSF does not have to apply this relief.

Segregated pension assets with losses might not apply the relief as losses will be disregarded but can be carried forward if incurred when unsegregated. For segregated pension assets in a gain position this relief will lock in the tax-free gain, with only future gains taxable. Fred and Wilma decide to apply the CGT relief to all assets that are in a gain position when re-valued at 30 June 2017.

As the CGT relief is not automatic, the fund will apply for the relief for each chosen asset in the approved form (regulations forthcoming) at 30 June.

4. How do they apply the capital gains tax relief?

All of Fred and Wilma’s SMSFs assets are segregated pension assets from 9 November to 30 June 2017 and are therefore eligible for the relief.

For each asset in a gain position the relief is applied at 30 June. The gain is locked in as tax free and disregarded in the 2016-17 annual return. The cost base of each asset is reset to be the current market value and this is irrevocable. Fred and Wilma decide not to apply the relief to assets in a loss position; the cost base of these assets will not be reset.

If Fred and Wilma had decided to complete the transfer to accumulation prior to 30 June 2017 then an actuarial certificate for the financial year might be required to claim ECPI.


At 1 July 2017, Fred will comply with the transfer balance cap by having a maximum pension balance in his ABP of $800,000 with the rest of his balance in a new accumulation account. The SMSF will use the proportionate method to claim ECPI from 2017-18 onwards.

Fred and Wilma will record the new cost base of fund assets which applied the CGT relief. When these are realised in the future the capital gain will be based on this new cost base, and the CGT discount will only apply if the asset is realised post 30 June 2018.


About the author
Melanie Dunn is the SMSF Technical Services Manager at Accurium.
Funds related to this article: Dynamic Markets Fund

Navigating the ups and downs of the market cycle. This fund uses dynamic asset allocation to actively adjust the split of investments across asset classes to achieve diversification in response to market changes.

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1Consumer Price Index (CPI) - the Reserve Bank of Australia inflation rate, trimmed mean

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